- Escalating tension in the Crimea
- Our baseline scenario is that the Ukraine remains united
- The RUB and UAH have dropped while gold and US Treasuries enjoyed safe haven support
After Ukraine’s pro-Russian president Yanukovich was ousted last week, Russia responded by stepping up military activity in the areas close to the Ukrainian border. Subsequently, special forces apparently liaised to Russia took over control in the Crimea, Ukraine’s southern peninsula. Tensions have escalated further after Russia’s Federation Council on 1 March approved president Putin’s request to send troops to Ukraine. Meanwhile, the new authorities in Kiev have placed their military on high alert. The international community has strongly criticized the Russian moves and has stressed the importance to safeguard Ukraine’s sovereignty and territorial integrity.
Sharp divisions between Ukraine’s Europe-leaning north and west and its Russia-leaning east and south mean that political typically do not occur smoothly, but come with significant political turmoil. This was the case during the 2004 Orange Revolution and this has now happened again, although with much more force and violence. These sharp divisions have the potential to destabilize Ukraine, if not managed properly both in a domestic and international context. The Crimea is a very special case, given that the peninsula has an ethnic Russian majority and a longstanding Russian past (transferred to Ukraine in 1954) and hosts the Russian Black Sea Fleet. Moreover, Crimea’s local authorities did not recognize the new government; they have planned a referendum on its status, which has been brought forward from 25 May to 30 March.
While political events in Ukraine and Russia are still highly in flux and events are evolving rapidly, we try to give some guidance by developing a number of tentative, high-level scenarios. Obviously, given the complexity of geopolitical events, a number of other many scenarios could be thought of as well, but we stick ourselves to three plausible ones (see for more detail our report Tensions in Ukraine published today).
1. Baseline – Ukraine remains united (including Crimea
Under this scenario, after a period of war mongering, we assume a normalization in the relations between Russia, the Ukraine and the West. This assumes a further ‘federalisation’ of the Ukraine, with more autonomy granted to the eastern regions including the Crimea.
2. Risk scenario 1 – Russia seizes Crimea
Under this scenario, Russia would gradually increase control over Crimea. This would result in a short military conflict between Russian and Ukraine and a re-escalation of ‘Cold War’ geopolitical tensions.
3. Risk scenario 2 – Ukraine breaks up.
This scenario assumes an escalation of protests and violence in eastern/southern Ukraine, making the country in its current form hardly governable and setting the scene for a split between the western/northern and the eastern/southern parts.
Since late November, developments in the Ukraine have come more and more to the fore. Initially, weakness was mainly concentrated to the Ukrainian hryvnia and its sovereign CDS spreads widened. As the situation has escalated, market impact has broadened. For starters, the Russian ruble has fallen under heaven pressure, Russian sovereign CDS spread has widened, the 10-Y US Treasury yield has dropped and gold prices have risen (safe haven demand). In a move to support the Russian ruble and to fight inflationary pressures, the central bank increased rates by 150bp to 7%, adding that the rate hike is temporary. Going forward, in our base scenario we expect that Ukraine remains united and that there will be a normalization of relations. This will likely result in a recovery of the RUB, pressure on gold prices and higher 10-Y US yield. The faith of the UAH is more closely linked to a potential default of the Ukraine (which will occur in the absence of external support).